Marx's Economics for Anarchists - Chapter 3

Cycles, Recessions, and the Falling Rate of Profit

This is Chapter 3 of my Marx's Economics for Anarchists: An Anarchist's Introduction to Marx's Critique of Political Economy. This chapter foces on the business cycle, crashes, and the theory of the falling rate of profit.

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Cycles, Recessions, and the Falling Rate of Profit

Classical political economists of Marx’s time and before, denied the inevitability of business cycles and their culminations in crashes. The capitalist market, they held, was so efficient a mechanism that it balanced what came into it and what came out, production and consumption, buying and selling, in a smoothly functioning process. There might be momentary, localized, disharmonies, in one industry of another, but no overall crashes. When things went wrong, it must be due to extra-economic factors: bad weather, wars, or government intervention into the market, which was always a bad idea.

Yet there have always been cycles, as long as capitalism has been in existence. There have been downturns between a third to a half of capitalist history from the early 19th century to the late ‘30s. (These downturns were called “crashes” or “panics” until a nicer term could be found: “depressions.” After the ten-year Great Depression of the 30s, they used the milder-sounding “recession.”) Today’s economists do not have much of a theoretical understanding of them. But they believe that with the use of governmental monetary manipulation, tax changes, and/or government spending, it is possible to modify the cycles, to minimize their downturns into insignificance. Too bad this has not worked out so well.

Cycles go from recovery from the depth of the last downturn, to increased productivity up to a new prosperity, to the beginning of a downturn, and then to the next crash. Then it starts all over again.

Marx was far ahead of his time in recognizing the reality of repeated business cycles and their resulting crises. He did not write out a full theory of the business cycle in one place, but his thoughts about it are apparent, especially in his discussion of capital accumulation. However his lack of one concentrated and complete statement has led Marxists to propose various theories of cycles and their crashes.

Marxist Theories of Cycles and Crashes

One of the most widespread misunderstandings of the capitalist cycle is held by people who do not know much Marxist economics. It is “underconsumptionism,” in its simplest form. This points out that the workers produce more than they can buy back. Therefore production is greater than the consumer market can absorb. The capitalists cannot sell all their commodities, which supposedly causes the system to collapse.

However, the workers always, at all times, produce more than they can buy back! Their products embody variable capital + constant capital + proft at the average rate (from surplus value). The workers can only buy the equivalent value of the variable value, which is equal to the sum of their wages. They can never buy back the constant or surplus values. If this was a problem, then capitalism would not merely have downturns, it would not work at all for a single minute. Fortunately, the constant and surplus values of the commodities do find markets, in other capitalists. They sell to each other. Capitalists who produce more than they had before (surplus value), can sell this extra to other capitalists. These have also wrung surplus value from their workers and also have more value than they had before, with which they can buy new commodities.

Capitalists who make machines and materials for production (whom Marx bundles into “Department I”) sell their products to other capitalists to use in their workplaces (or rather to employ more workers to use the machinery). The consumer goods capitalists (in “Department II”) use their constant capital value equivalent to buy machines, etc., to replace old machines, and use surplus value equivalents to buy new machines, etc., in order to expand. The workers in both departments spend their wages on consumer goods (from Department II). The capitalists can expand, using their surplus value to hire more workers (who can now buy more consumer goods). The capitalists and their families also buy luxury consumer goods, a small fraction of Department II products.

Of course, this expansion of production and sales will require an expansion of money. In the early days of capitalism, the owners of gold mines would keep on producing more gold (that is, hiring more workers to dig more gold). These days, the government works with the banks to put out more paper money or credit.

A more sophisticated model of the cycle is called “overproduction” (or “overaccumulation”): In its drive to expand, capitalism puts more money into constant capital than into variable capital. It is constantly seeking to expand labor productivity, which means more machines and materials, and fewer workers in proportion. (That is, the number of workers may increase, but not as fast as the amount of machinery.) Also, the capitalists are driven to increase surplus value, which requires holding down the workers’ pay. Even in times of prosperity, when the capitalists are must willing to let the workers increase their pay (due to shortages of labor plus high levels of profit), the bosses are still reluctant to increase wages.

As a result, production of consumer goods (among other goods) tends to expand more and faster than do the wages of the workers. In other words, production of consumer commodities expands more and faster than does the consumer market. And if the consumer goods-producing capitalists (Department II) cannot sell their goods, they will not buy from the machinery-producing capitalists (Department I), who now also cannot sell their products. If goods cannot be sold, then their values cannot be “realized.” At least, until the next crisis, when the “extra” goods are either sold off (often below value) or are just destroyed, and the cycle can start again.

Another view incorporates this overproduction hypothesis. It is called “disproportionality.” The capitalist system is a very complex system. To work, the different parts have to match up with each other, not only consumer goods production and the consumer market (overproduction), but each commodity must match with its need. Raw materials, production of machinery, use of machinery, the right numbers of everything, the right amount of money for the different capitalists to buy the right product at each stage of production, the right workers in the right numbers with the right skills at the right wages, the right distribution of commodities, the right amount of credit, and so on. Each commodity has both a use-value and a value, so each must fit into the complex process at the right time and in the right place. While the bourgeois economists speak of the market as a smoothly running mechanism, in fact it lurches forward with herky-jerky motions. Of course, it produces ups and downs, prosperities and recessions.

While there is much truth in the overproduction and disproportionality concepts of cycles, as such they leave out what needs to be at the center of any analysis of capitalism: the production of profit. This is what drives all capitalist production, what it is all about, and it makes all the difference. If the production of profit is very high, then the capitalists will expand, hiring more workers and being (relatively) more willing to raise their salaries. This will expand the consumer market. Meanwhile, in order to expand, they will be more willing to buy materials and machines from each other. Higher profits prevent overaccumulation (and “underconsumption”). Similarly, higher profits counter disproportionalities. It greases the wheels. With more profits, things go smoother and match up better. Conversely, lower profits have the opposite effect, increasing “overproduction” and disproportionality. There seems to be “too much” of some commodities only because there is “too little”, namely too little surplus value.

The Tendency of the Rate of Profit to Fall

As mentioned, each capitalist firm seeks to raise its profits by using the most modern technology, the most productive methods. This means investing in more and better machinery, in order to raise their workers’ per-person productivity. They may hire more workers, as they expand, but they buy even more machinery, and materials to go through the machinery.

As a result, the enterprise’s workers will be able to produce more goods in the same amount of time, each good cheaper than the competitors’ version. The owners of the factory will be able to flood the market with their cheaper goods--although they may charge a higher mark-up (profit) than do their competitors. They will win a larger market share and—what is the point—make an extra-large profit. (By these methods, their greater investment will get a larger share of the total surplus value produced by all the capitalist firms.) Eventually the competitors will catch up with them by also installing the new type of machinery. Or the competitors will go bankrupt. Either way, the original initiators will have established a new normal as a level for productivity in the industry.

The individual factory makes a larger profit, but actually it contributes a smaller proportion of surplus value than before. Profit is nothing but the unpaid labor ot the workers. The purpose of machinery is to displace labor, to use less labor to make more things. The factory owners may have more surplus value because they hire more workers, but they have bought even more machines, so the ratio of surplus value to the total investment goes down. And when the whole industry adopts the new technology, the whole industry will be producing a lower ratio of surplus value.

When most of an economy has adopted similar new technology, the total ratio of surplus value will have decreased. The total amount invested (included constant capital) will have increased, but the total amount of surplus value, for all society, will not have increased proportionally. The total mass of surplus value may have increased or decreased, according to the number of workers employed, but its ratio to the total invested will not have increased. Which is to say that the profit rate will decrease. (The classical political economists had noticed the falling rate of profit before Marx, but had no good explanation for it.)

The basic ratio of machinery and materials to workers is a “technical composition.” (It is unclear how this can be measured. Perhaps by weight?) If measured by the value of the constant capital to the variable capital (by how much each component costs, in money or labor-time), this is the “value composition.” Put both together and there is what Marx refers to (for some reason) as the “organic composition.” The more machinery, the higher the organic composition—and the lower the rate of profit produced.

The whole point of increasing machinery in production is to decrease the amount of labor used. Higher productivity forces out labor. A pool of unemployed workers is created, which Marx calls “the reserve army of labor.” Some are immediately available for work (members of the “floating” reserve army of labor). Others are busy elsewhere but can be called upon if more workers are needed (referred to as the “latent” reserve army). This includes poor peasants and also women homemakers. Women may be attracted (or forced) into the labor force when there is a shortage of (mostly low-paying) labor. But they can always be pressured back into the families when no longer “needed.” At least that has been the history so far.

Recessions as Healthy

The rate of profit affect the business cycle. As the economy expands again, after the last downturn, the rate of profit first goes up. But once the cycle reaches its peak, the rate goes down. New machinery has increased the organic composition of capital overall, which causes the rate of profit to decline. Meanwhile, the capitalists have been forced to raise the pay of at least part of the working class. This is due to the increasing shortage of workers as production expands, including bottlenecks caused by lack of skilled workers. Workers are more likely to strike for better wages and conditions, and the capitalists are more willing to give in. This too lowers the rate of profit.

To keep their profits coming in, capitalists borrow money from banks and each other. Debts pile up. They speculate, invest in shaky schemes, and buy into “bubbles.” This is made easier by the split in the economy between the actual commodities, the factories, and other things which were made by people, and the pieces of paper which give ownership of the things. The first is called by bourgeois economists the “real economy” and it includes goods and services which embody value. The second is called the “paper economy” or the “virtual economy.” Stock certificates provide capitalists with claims on surplus value. They are bought and sold with little relationship to the actual workplaces and work processes where the value is created. In Marx’s terms, these are “fictitious capital.”

Finally there is a crash. And a good thing too. The recessions are essential for the profitablility of the capitalist economy. Weak companies, with old-fashioned technology, will go bankrupt. Their technology will either be junked or bought-up cheaply by better-run companies. Machinery in general will be cheapened during the downturn. So will labor power. There will be more uemployed; workers will be forced to accept lower pay. “Overproduced” goods will be sold off (or destroyed). Depts and speculations will be wiped out in bankruptcies. Stronger companies will buy up resources from weaker ones, creating larger corporations. All these factors clear the way for a more profitable economy.

And so there will be a new upturn, moving toward a new period of prosperity. The collapse of the crisis was essential for clearing out the deadwood and preparing for the new and bigger upturn.

Countertendencies to the Falling Rate of Profit

There are countertendencies to the tendency of the rate of profit to fall. The business cycle, particularly the downturn, mobilizes these counteracting tendencies and restores profitability.

There are a number of such countertendencies. For example, the rate of turnover, from investment to the sale of products to reinvestment, varies from industry to industry. In itself, this may cause disproportionality. But the more rapid the turnover, the higher the rate of profit.

Imperialism, in its various forms, also increases profts. It may bring in commodities with lower costs and bigger profits than can be produced at home.

The main counteracting tendencies are caused by the very expanded productivity which (due to the increased organic composition of capital) causes the rate of profit to fall in the first place. Expanded productivity makes cheaper (less valuable) commodities. If this becomes widespread, then the constant capital bought by the industrial capitalist (the machines and materials) become cheaper. Whether or not the capitalist goes out and buys the cheaper machines, the ones the capitalists keep will lose their value, become cheaper. If the capitalist makes the same profits as before, it is now compared to cheaper investment costs, and therefore the rate of proft goes up.

The same is even more true for the other costs of the industrial capitalist, the wages of the workers. As productivity increases in general, the goods which the workers buy to maintain and reproduce themselves become cheaper. The food, clothing, shelter, entertainment, and education which make up the cost of the workers’ commodity labor power, all cost less labor to make (cost less value). It is now possible to lower the workers’ wages and yet to maintain their standard of living. The use-value of the goods they earn remains the same while the exchange value of their pay goes down. (This lowering of pay may be done by directly cutting it or—less provocative to the workers-- by inflation.) The use-values the workers can buy may stay the same—or even increase!—while the proportion they receive of the value they produce decreases. So surplus value increases, without necessarily lowering the standard of living of the workers. (This trend also makes it difficult to tell if the workers in a more industrialized country, with a higher standard of living, are being more or less exploited than workers in a poorer country.)

Further, capitalist firms get larger and larger, more and more concentrated (see below). This does not directly counteract the fall of the rate of profit. But it does produce larger amounts of surplus value in one place. This goes far to counter the immediate effects of the falling rate. (On the other hand, the larger enterprises get, the more capital is needed for investing in them, which a falling rate of profit makes it harder to acquire.)

The tendency of the falling rate of profit is a major factor in the business cycle, behind disproportionality and overproduction. Historically it is countered and set right by the downturn phase of the cycle, which restores capitalism to profitability. So the system lurches forward.

Does this mean that the counteracting effects can so compensate for the falling rate of profit that over the long run it becomes meaningless? No. It is observable that, over time, the organic composition of capital (including the value composition) has increased, despite counteracting tendencies. John Henry may have used a sledge hammer but he was beaten by the steam drill, which has since been replaced by gigantic automated mining equipment. Shovels have been replaced by earth-moving machines as big as houses. Steel puddling by almost-automated factories. Horses by trucks, railroads, and airplanes. Paper and pencils by computers. True, the difference in value between a pickax and an earthmoving machine may be less than their difference in weight. Yet the tractor does cost much more than the shovel. And the number of workers it takes to dig the same size hole has gone way down. This should lead to a long term trend toward a lower rate of profit.

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Next will be Chapter 4: "Primitive Accumulation"

Previous Chapters:
Chapter 1 - An Anarchist's Introduction to Marx's Critique of Political Economy
Chapter 2 - The Labor Theory of Value